The inflation and interest rate picture in Asia-Pacific remains mixed. In many economies, modest core inflation momentum suggests limited or no further monetary policy tightening this year. But in some economies recent hefty increases in core prices are forcing central banks to consider more rate hikes. Australia, New Zealand, and the Philippines belong in this group, in our view.

We should be cautious about expectations of a steady decline in U.S. inflation. The labor market there is strong; unemployment remains low, and wages are rising briskly. Indeed, we expect the U.S. Federal Reserve to raise the policy rate above 5% this year. We also see the market expectations of rates falling meaningfully later in 2023 as unrealistic. The decline in sequential U.S. core price increases is nonetheless welcome. If it continues, year-on-year core inflation will retreat (see chart 1).

What has helped contain headline inflation is the fall in global energy and commodity prices since mid-2022 (see chart 2). In the U.S., this has moderated overall consumer inflation. Exacerbating this impact are slowing core price increases (excluding food and energy) on a month-on-month basis.

Rate Developments In Asia-Pacific Have Met Expectations

Inflation and policy interest rate developments in Asia-Pacific in the past six months have broadly been in line with our expectations in July 2022.

At that time, we stressed that rising core inflation in key economies was different to previous spikes in energy and commodity prices. This is what's been prodding central banks to rapidly lift rates (see "Asia-Pacific: Varying Core Inflation Paths Drive Monetary Policy Divergence," July 25, 2022). We found that core inflation was generally lower in Asia-Pacific than in the U.S., requiring less hawkish central bank policy tightening. Conversely, we pointed to jumps in core inflation in Australia, South Korea and, especially, New Zealand, and sustained elevated core inflation in India.

Chart 1

Chart 2

Amid lower energy and commodity price pressure, the recent low pace of sequential core inflation in most Asia-Pacific economies implies central banks won't have to raise policy rates much this year.  Recent month-on-month increases in core prices have often been at least as low as in the U.S. In China, Indonesia, Japan, Taiwan, and Thailand core inflation never really took off meaningfully (chart 3). In Malaysia, South Korea, and Singapore, monetary policy tightening and a slowing economy choked off a burgeoning rise in core prices (see chart 4).

In China, we expect the increase in consumer inflation this year to remain moderate and don't think the People's Bank of China will raise its policy rate this year.  China's re-opening will increase price pressures globally and domestically, but the effect should be modest. Rising mobility, economic momentum, and the eventual stabilization of the country's housing market should propel global energy and commodity prices.

However, the likely drivers of China's recovery are domestically oriented consumption and services activity. So the hit should be mild. This is especially the case when you compare it with the combined effect of the re-opening of the rest of the world, the Russian invasion of the Ukraine, and lingering supply chain issues in 2021-2022. Domestically, while price pressure is likely to emerge in contact-intensive services, most goods markets in China are oversupplied. Moreover, the overhang of excess saving is smaller than in the U.S. and Europe.

For Japan, we think some small monetary policy tightening is possible later this year.  Rising inflation was among the factors leading to market pressure for tightening in January. This followed an increase of the cap on the 10-year government bond yield by the Bank of Japan (BOJ) that it would defend under its yield curve control. However, increases in core prices (as internationally defined) have remained low. The BOJ decided against further changes because it is expecting wage increases to remain moderate and headline inflation to fall below 2% again toward the end of 2023. It was also factoring in subdued global growth.

The central banks of Korea, Indonesia, and Taiwan have broadly finished raising rates, in our view.  Despite low recent core inflation, we expect the Bank of Thailand to raise rates significantly in 2023, from the current low level of 1.25%, as economic growth picks up amid the tourism recovery.

Conversely, in some Asia-Pacific economies, elevated core inflation in recent months is fueling expectations of further policy rate increases.  In India core inflation has been elevated for longer; however, it eased sequentially in the second half of 2022. An already elevated 6.25% policy rate limits the need for further increases.

In Australia, New Zealand, and the Philippines the case for central banks to raise policy rates further seems strong.  Amid resilient domestic demand in these economies, core inflation rose throughout 2022 and reached an average of 0.7%-0.9% a month in the fourth quarter. This implies an annualized pace of 10.7%, 8.1% and 8.6%, respectively.

Chart 3

Chart 4

In all, the coming six months are likely going to show significant differentiation in central bank policy moves, depending on the domestic inflation trajectory, with some countries raising rates as others stay pat.

Related Research

• China's Earlier Policy Shift Advances Its Recovery, Jan. 18, 2023
• Asia-Pacific: Varying Core Inflation Paths Drive Monetary Policy Divergence, July 25, 2022

Editor: Lex Hall